Provident Financial Services, Inc. (NYSE:PFS) Q2 2023 Earnings Call Transcript

Provident Financial Services, Inc. (NYSE:PFS) Q2 2023 Earnings Call Transcript July 28, 2023

Operator: Thank you for standing by. At this time, I would like to welcome everyone to the Provident Financial Services, Inc. Second Quarter Earnings Conference Call. [Operator Instructions] Thank you. Adriano Duarte, Investor Relations Officer. You may begin your conference.

Adriano Duarte: Thank you, Cheryl. Good morning, everyone, and thank you for joining us for our second quarter earnings call. Today’s presenters are President and CEO, Tony Labozzetta, and Senior Executive Vice President and Chief Financial Officer, Tom Lyons. Before beginning their review of our financial results, we ask that you please take note of our standard caution as to any forward-looking statements that may be made during the course of today’s call. Our disclaimer — our full disclaimers contained in last evening’s earnings release, which has been posted to the Investor Relations page on our website provident.bank. Now it’s my pleasure to introduce Tony Labozzetta, who will offer his perspective on our second quarter. Tony?

Tony Labozzetta: Thank you, Adriano. Good morning, everyone, and welcome to the Provident Financial Services earnings call. The disruption to the banking system and resulting volatility that we all experienced in the first quarter has abated and Provident Bank fared well through the instability. These events, however, combined with more rate hikes by the Federal Reserve gave rise to new headwinds for the banking industry in the form of funding challenges as we headed into the second quarter. These funding challenges included more demands by customers for higher rates, needs for more insurance, a disintermediation from low-cost deposits to higher-yielding time deposits and certain deposits shifting to treasury securities. Consequently, we experienced higher deposit betas for the quarter, which increased our funding costs and compressed our net interest margin.

Despite these unfavorable market conditions, Provident produced good financial results this quarter, which once again demonstrates the strength of our franchise and talented management team. As a result, we reported earnings of $0.43 per share, an annualized return on average assets of 0.93% and a return on average tangible equity of 10.75%. Excluding merger-related charges and normalizing the CECL provision for stabilized economic forecast, we estimate our core return on average assets was approximately 1.07% for the second quarter. Our capital is strong and comfortably exceeds well capitalized levels. Tangible book value per share expanded 3.6% during the first six months to $15.66 on the strength of our earnings. Our tangible common equity ratio on June 30, was 8.72%.

As such, our Board of Directors approved a quarterly cash dividend of $0.24 per share payable on August 25. Presently, our uninsured and uncollateralized deposits were $2.7 billion or approximately 26% of our total deposits. Our on-balance sheet liquidity plus borrowing capacity is $3.8 billion or 140% of uninsured deposits. Our core deposits are a valuable component of our franchise. During the quarter, our core deposits decreased $55 million or 0.7%, which we attribute to normal business activity and customers seeking higher yields on their deposits. For the second quarter, our deposit beta was 148%, with the rising rate cycle to date deposit beta was about 25%. Consequently, our total cost of deposits increased and in large part, drove our total cost of funds up 50 basis points to 1.71% and compressed our net interest margin 37 basis points.

Our commercial lending team closed approximately $516 million of new commercial loans during the second quarter. Prepayments decreased 56% to $125 million as compared to the trailing quarter. Our credit metrics remained strong in the second quarter, and we continue to maintain prudent underwriting standards, particularly in CRE lending. As part of our normal CRE monitoring processes, we have performed targeted in-depth analysis to evaluate portfolio and loan level risks. Our line of credit utilization percentage increased 4% in the second quarter to 35%, which is approaching our historical average of approximately 40%. As a result of the improved production, reduced prepayments and increased line utilization, our commercial loans grew $315 million or 3.6% for the quarter.

For the six months, we grew $296 million or 3.4%, which is pacing at an annualized growth rate of about 6.7%. The pull-through in our commercial loan pipeline during the second quarter was good, and the gross pipeline remained strong at approximately $1.7 billion. The pull-through adjusted pipeline, including loans pending closing, is approximately $1 billion, and our projected pipeline rate increased 47 basis points to 7.24%. We are encouraged by the strength and quality of our pipeline. In addition, payoffs have slowed. As a result, we expect to achieve our commercial loan lending growth targets for the remainder of 2023. Our fee-based businesses performed well this quarter. Provident Protection Plus had an outstanding second quarter with 82% organic growth, which resulted in a 34% increase in revenue and an 87% increase in operating profit as compared to the same quarter last year.

The conditions in the financial markets were more stable in the second quarter. And as a result, Beacon Trust experienced growth and market value of assets under management and related fee income. Beacon’s fee income remained stable compared to the trailing quarter as the increase in advisory fees was mostly offset by a reduction in trust revenue. With respect to our previously announced merger with Lakeland Bancorp, we continue our engagement with the regulators and have provided additional information in order to further support our application for approval of the merger. The companies have made significant progress in various integration initiatives through outstanding teamwork from both banks. We look forward to receiving regulatory approval and combining our two great franchises into the best bank in New Jersey.

As we look forward, we remain focused on growing our business. However, staying disciplined and committed to our risk management principles is critical during these challenging times. In addition, we expect to close and integrate the merger with Lakeland Bank in the near future, which we believe will create value for all of our stakeholders. Now I’ll turn the call over to Tom for his comments on our financial performance. Tom?

Tom Lyons: Thank you, Tony. And good morning, everyone. As Tony noted, our net income for the quarter was $32 million or $0.43 per share compared with $40.5 million or $0.54 per share for the trailing quarter and $39.2 million or $0.53 per share for the second quarter of 2022. Non-tax deductible charges related to our pending merger with Lakeland Bancorp totaled $2 million in the current quarter and $1.1 million in the trailing quarter. Excluding these merger-related charges, pretax pre-provision earnings for the current quarter were $55.3 million or an annualized 1.6% of average assets. Revenue totaled $118 million for the quarter compared with $130 million for the trailing quarter and $120 million for the second quarter of 2022.

Our net interest margin decreased 37 basis points from the trailing quarter to 3.11%. Yield on earning assets improved by 10 basis points versus the trailing quarter as floating and adjustable rate loans repriced favorably and new loan originations reflected higher market rates. This improvement in asset yields, however, was more than offset by an increase in interest-bearing funding costs. Increased funding costs reflected current market conditions, which resulted in an increase in borrowings accompanied by a decrease in deposits. Certain noninterest-bearing balances also moved to our interest-bearing and insured cash sweep product in order to obtain increased deposit insurance. In addition, lower costing demand and savings balance has shifted to higher costing time deposits.

The average total cost of deposits increased 37 basis points to 1.42%. This brought our rising rate cycle to date beta to 25%. The average cost of total interest-bearing liabilities increased 59 basis points in the trailing quarter to 2.13%. The prolonged inverted yield curve, ongoing deposit competition and an increase in the attractiveness of investment alternatives continue to impact funding costs. As a result, we expect to see some continued net interest margin compression for the balance of 2023 and project the margin will stabilize at around 3%. Period end total loans grew $306 million with commercial loans increasing $315 million for the quarter. Our pull-through adjusted loan pipeline increased $109 million from last quarter to $1 billion with a weighted average rate of 7.24% versus our current portfolio yield of 5.24%.

The provision for credit losses on loans increased $4.4 million for the quarter to $10.4 million, primarily due to a worsened commercial property price index forecast. As a result, the allowance for credit losses on loans increased to 97 basis points of total loans at June 30 from 91 basis points at March 31. Current credit metrics, however, were stable and annualized net charge-offs were just 4 basis points of loans for the quarter. Non-interest income decreased $2.8 million versus the trailing quarter as a $2 million gain related to a prior quarter sale of REO was realized upon the satisfaction of post-closing conditions in the trailing quarter. In addition, deposit fees were down $612,000 versus the trailing quarter, and insurance agency income, while ahead of plan for the second quarter, was $255,000 less than the seasonally strong first quarter.

Excluding provisions for credit losses on commitments to extend credit and merger-related charges, non-interest expense decreased $4.5 million versus the trailing quarter, with $3.5 million of that decline coming in compensation and benefits expense as incentive accruals, stock-based compensation and employer payroll tax expense were all lower than the trailing quarter. Adjusted operating expenses were an annualized 1.83% of average assets for the current quarter compared with 2% in the trailing quarter and 1.92% for the second quarter of 2022. The efficiency ratio was 53.29% for the second quarter of 2023 compared with 51.85% in the trailing quarter and 53.83% for the second quarter of 2022. That concludes our prepared remarks. We would be happy to respond to questions.

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Q&A Session

Operator: [Operator Instructions] Your first question is from Mark Fitzgibbon of Piper Sandler. Please go ahead. Your line is open.

Mark Fitzgibbon: Hey, good morning, guys. Happy Friday.

Tony Labozzetta: Good morning, Mark.

Mark Fitzgibbon: Tony, I wondered if there’s anything left that you all need to do or provide to the regulators, or have you sort of done all that? And do you have any rough sense what the timing might look like for closing on the Lakeland deal?

Tom Lyons: Yeah. So I mean what I can say to that is that — we have weekly meetings with — calls with the FDIC to ensure that any questions that are open or anything that’s pending has been provided. So we are — what I look at this is like we’re on the back end of that, right? We’ve given them everything that they need to process the application. Will a question or two arise during their, what I would call, a final analysis? Sure. But from my perspective, and I know I get guided by counsel not to be too forward on this, it just appears that everything is there and they have to go through their process. And so I’m expecting it to happen relatively soon.

Mark Fitzgibbon: Great. And then second question, Tom, on the expense trends, obviously, they were great this quarter. And it sounded like expenses might tick up a little bit in the third quarter. Did I hear that correctly?

Tom Lyons: I think we’ll be able to maintain in the $64 million to $65 million range, Mark. I think like a lot of our peers were cognizant of the pressure net interest margins put on earnings, and we’re looking carefully at all our expenses.

Mark Fitzgibbon: Okay. And I heard your comments also on the margin sort of bottoming out around 3%. Is that assumed in the third quarter?

Tom Lyons: Yes, I think so, Mark. Comes in around 3% and stays there.

Mark Fitzgibbon: Okay. And with the strong pipeline that you have and given sort of the softening economic situation, how are you thinking about provisioning levels for the back half of the year?

Tom Lyons: No. I think about the total coverage at 97 basis points, and I don’t really see it going much higher than that. That was really responsive to the economic forecast, in particular, the commercial property price index, rely on Moody’s baseline for economic forecast. And I think they were a little bit slower than some other forecasters may be in catching up on their view of what CRE potential losses. That said, our own book is quite strong, as you saw, really strong in the asset quality metrics overall and no concerns reflected in the current book.

Mark Fitzgibbon: Great. Thank you.

Operator: Your next question is from Billy Young of RBC Capital Markets. Please go ahead. Your line is open.

Billy Young: Hey. Good morning, guys. Can you hear me okay?

Tony Labozzetta: Perfectly.

Billy Young: Great. Maybe kind of a two-part question here to start. First, on loan growth, it looks like you’re set up to have continued nice growth into the third quarter with the stronger adjusted pull-through pipelines. Kind of what are your thoughts — I guess, what are your thoughts on growth in the back half of the year? And then secondly, can you give us an update on your thoughts on funding going forward from here, particularly given the loan-to-deposit ratio at close to 103%?